Question

how do exchange rates adjust to changes in foreign and domestic income?

Answer 1

When domestic income increases we can infer that the productivity in the economy increases and their demand for foreign goods increases too. This means that the demand for foreign currency increases in the forex market therefore the domestic currency depreciates and foreign currency appreciates implying the shift down of exchange rate. And the vice versa happens when domestic income decreases.

On the other hand, increase in foreign income takes a hit at the balance of payments, thereby depreciating the country's currency. And the vice versa is true when foreign income decreases  

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